Lenders can avoid some foreclosure pitfalls if they have a working
familiarity with the finer points of state foreclosure law.

Particularly in these times, with the economy performing so poorly
and unemployment remaining stubbornly high, mortgage lenders would be
wise to become more familiar with the legal procedures involved in
foreclosing on real estate collateral. Being familiar with these legal
procedures will help a lender communicate in a more meaningful way with
legal counsel and hopefully help to avoid the pitfalls and costs
associated with mortgage foreclosures. This article addresses some of
the fundamental issues involved in foreclosing on real estate in the
state of Pennsylvania.

Mortgage foreclosure lawsuit vs. lawsuit under the note

In standard loan documentation, the borrower signs a note, whereby
the borrower promises to repay the loan. The borrower also signs a
mortgage, whereby the borrower gives the lender a lien on the
homeowner's property, which can be foreclosed if the individual
fails to pay the loan. Accordingly, the note represents the
borrower's promise to pay and the mortgage represents the
lender's security for the borrower's promise to pay. Because
the lender holds both a note and a mortgage from the borrower, the
lender faced with a delinquent loan must decide whether to sue under the
note or to sue under the mortgage (i.e., foreclose the mortgage).

If the borrower or any guarantor has personal liability for the
loan, or if the mortgage encumbers multiple parcels of real estate
located in different counties, a lender will almost always be better off
suing under the note because of Pennsylvania's Deficiency Judgment Act.

Pennsylvania's deficiency judgment procedures provide that if
the lender is the successful bidder at the sheriff's sale for the
property and then wants to pursue the borrower or any guarantors
personally after the sale has occurred, the lender must first petition
the court to fix the fair market value of the real estate in question.
Under this procedure, the court will determine the fair market value of
the property sold at sheriff's sale and the value determined by the
court will be deducted from the sum owed to the lender.

The petition to fix fair market value must be filed within six
months of the date of delivery of the sheriff's deed (although it
would be more prudent to file it within six months of the actual sale.)
This procedure, which is set forth in Pennsylvania's Deficiency
Judgment Act, is designed to prevent the lender from obtaining a
windfall. Such a windfall could arise if the lender obtained title to
the mortgaged property at sheriff's sale (which might be worth the
amount of the outstanding loan), and then pursued the borrower
personally for the unpaid loan without giving the borrower credit for
the value of the property sold at sheriff's sale.

The Pennsylvania courts have held that prior to filing a petition
to fix fair market value, the lender must have first obtained a
"personal judgment" against the borrower. Only a lawsuit based
on the borrower's liability under the note will result in such a
personal judgment. A mortgage foreclosure lawsuit will not result in a
personal judgment. Accordingly, a major advantage of the lawsuit based
on the borrower's liability under the note is that it results in a
personal judgment.

If the lender's mortgage encumbers separate parcels of real
estate located in a number of different counties, and the lender
acquires one of the parcels at a sheriff's sale, the lender must
also petition to fix fair market value prior to holding a sheriff's
sale on the next parcel of real estate. This is because
Pennsylvania's Deficiency Judgment Act requires an
"accounting" of the value of the mortgaged real estate
purchased by the lender at foreclosure sale prior to allowing the lender
to pursue the subsequent foreclosures. As previously mentioned, this
procedure is designed to prevent the lender from obtaining a windfall in
foreclosing on the initial parcel of property, which might be worth the
outstanding amount of the loan, but then pursuing sheriff's sales
against the other encumbered real estate without giving the borrower
credit for the property previously sold at sheriff's sale.

A successful lawsuit under the note also has the advantage of
resulting in a lien on all of the borrower's real property in the
county where a judgment is entered, or any county where the judgment is
transferred. A judgment in a mortgage foreclosure lawsuit will not
result in a lien on any property other than the mortgaged property.

Advantage of a mortgage foreclosure lawsuit

If the borrower has transferred the mortgaged property following
the original loan closing, there is at least one distinct advantage to
bringing a mortgage foreclosure lawsuit in lieu of a lawsuit on the
note. In a mortgage foreclosure lawsuit, the lender may refrain from
naming the original borrower in the foreclosure complaint if the lender
expressly releases the original borrower from all liability for the debt
secured by the mortgage. This is extremely helpful if the original
borrower is involved in bankruptcy proceedings.

Confession of judgment

A variation of a lawsuit under the note is the confession of
judgment lawsuit for money, which allows the lender to immediately
obtain a judgment against the borrower. However, a lender can only
confess judgment for money against a defaulting borrower if the loan
documents expressly authorize the confession of judgment procedure,
which is common for commercial loan documents in Pennsylvania.

With a confession of judgment, judgment is obtained immediately by
the lender against the borrower without any adversary proceeding and the
burden is on the borrower to challenge the judgment. One of the major
benefits of the confession of judgment is that the lien of the judgment
and any proceedings to enforce the lien (for example, a sheriff's
sale of the mortgaged property and/or seizure of the borrower's
bank accounts) will continue without interruption while any proceedings
instituted by the borrower to challenge the judgment are pending. This
is the case unless a stay is granted to the borrower by the court.
Consequently, with a confession of judgment, it is theoretically
possible to conduct the sheriff's sale prior to a court ever
deciding the validity of a borrower's challenge to the
"foreclosure" proceeding.

Lenders should be aware that there are restrictions against using
confessed judgments to execute against residential real estate (one to
two units), and legal counsel should be consulted prior to pursuing this
course of action.

In summary, the confession of judgment procedure has the advantage
of being fast, and because it is a variation of a lawsuit based on the
note, it also has the advantage of resulting in a personal judgment.

Sheriff's sales notice

Once judgment against the borrower is obtained, the lender must
comply with specific notice and advertising requirements before a
sheriff's sale can be held. The Pennsylania rules require
advertising in each of the three weeks prior to the sale, posting notice
on the property and written notice to all parties having any record
lien, any record interest or any other interest of which the judgment
creditor has knowledge.

The general rule for lenders bidding on property being sold at a
sheriff's sale is that the foreclosing lender should bid up to an
amount equal to the lesser of (1) the fair market value of the property
(determined by a recent appraisal) or (2) the sum of (a) the amount of
the lien in question plus (b) all prior liens to be divested by the sale
plus (c) costs. Note that under clause (2) of this formula, one cannot
determine the maximum amount to bid without being certain of the
priority of any potentially intervening liens.

The formula in the previous paragraph is designed so that the
lender will keep bidding until the bidding reaches a point that will
generate proceeds to the lender equal to the outstanding amount due
under the loan. However, in any case, the lender will not normally bid
higher than fair market value, because if it is the successful bidder at
the sale, it cannot hope to obtain more than fair market value on a
resale.

It is important for a lender to distinguish between the issue of
whether a particular lien is divested at a sheriff's sale, as
opposed to whether a particular lien is a superior lien for purposes of
distribution of proceeds from the sale. The failure to distinguish these
two concepts may result in the lender making erroneous bidding
calculations. As noted, a lender in Pennsylvania should only take into
account other liens in its bidding calculation if such other liens are
both prior to the lender's lien and such other liens will be
divested by the sale. Of course, prior liens that are not divested by
the sale must be taken into consideration for the purpose of computing
fair market value. Legal counsel should be consulted in connection with
bidding calculations in any case where a prior lien is involved.

Transfer tax

Lenders should not forget the possibility that the transfer of
title for the mortgaged property pursuant to a sheriff's sale may
be subject to transfer tax. The Pennsylvania transfer tax statute
exempts the lender from the tax if it is the successful bidder at the
sale and the grantee on the sheriff's deed. (That is, a tax will be
imposed if the lender's successful bid is assigned to an affiliate
or a third party.) However, the transfer tax imposed by the city of
Philadelphia is still due even if the lender acquires the property,
unless the lender was the seller of the property that provided financing
to the purchaser.

As the above discussion indicates, mortgage foreclosures are
fraught with legal complexities. However, mortgage lenders who recognize
the basic issues involved will be more likely to ask their attorneys the
right questions and successfully avoid some of the pitfalls lurking in
this area.

Robert A. Silverman is a partner in the Philadelphia law firm of
Wolf, Block, Schorr and Solis-Cohen, practicing in the firm's Real
Estate Department and Workout Group. Seth D. Geldzahler is an associate
in the firm's Real Estate Department.

COPYRIGHT 1992 Mortgage Bankers Association of America
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